finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fina ...

, an abnormal return is the difference between the actual

return Return may refer to: In business, economics, and finance * Return on investment (ROI), the financial gain after an expense. * Rate of return, the financial term for the profit or loss derived from an investment * Tax return, a blank document or t ...

of a

security Security is protection from, or resilience against, potential harm (or other unwanted coercive change) caused by others, by restraining the freedom of others to act. Beneficiaries (technically referents) of security may be of persons and social ...

and the

expected return The expected return (or expected gain) on a financial investment is the expected value of its return (of the profit on the investment). It is a measure of the center of the distribution of the random variable that is the return. It is calculated ...

. Abnormal returns are sometimes triggered by "events." Events can include

merger Mergers and acquisitions (M&A) are business transactions in which the ownership of companies, other business organizations, or their operating units are transferred to or consolidated with another company or business organization. As an aspect ...

dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-in ...

announcements, company earning announcements, interest rate increases,

lawsuit - A lawsuit is a proceeding by a party or parties against another in the civil court of law. The archaic term "suit in law" is found in only a small number of laws still in effect today. The term "lawsuit" is used in reference to a civil actio ...

s, etc. all of which can contribute to an abnormal return. Events in finance can typically be classified as information or occurrences that have not already been priced by the

market Market is a term used to describe concepts such as: *Market (economics), system in which parties engage in transactions according to supply and demand *Market economy *Marketplace, a physical marketplace or public market Geography *Märket, an ...

Stock market

stock market A stock market, equity market, or share market is the aggregation of buyers and sellers of stocks (also called shares), which represent ownership claims on businesses; these may include ''securities'' listed on a public stock exchange, as ...

trading, abnormal returns are the differences between a single stock or portfolio's performance and the expected return over a set period of time. Usually a broad index, such as the

S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of D ...

or a national index like the

Nikkei 225 The Nikkei 225, or , more commonly called the ''Nikkei'' or the ''Nikkei index'' (), is a stock market index for the Tokyo Stock Exchange (TSE). It has been calculated daily by the '' Nihon Keizai Shimbun'' (''The Nikkei'') newspaper since 1950 ...

, is used as a benchmark to determine the expected return. For example, if a stock increased by 5% because of some news that affected the stock price, but the average market only increased by 3% and the stock has a

beta Beta (, ; uppercase , lowercase , or cursive ; grc, βῆτα, bē̂ta or ell, βήτα, víta) is the second letter of the Greek alphabet. In the system of Greek numerals, it has a value of 2. In Modern Greek, it represents the voiced labiod ...

of 1, then the abnormal return was 2% (5% - 3% = 2%). If the market average performs better (after adjusting for beta) than the individual stock, then the abnormal return will be negative. :

\textrm\ \textrm = \textrm\ \textrm - \textrm \ \textrm

Calculation

The calculation formula for the abnormal returns is as follows:

AR_=R_-E(R_)

where: AR_it - abnormal return for firm i on day t R_it - actual return for firm i on day t E(R_it) – expected return for firm i on day t A common practice is to standardise the abnormal returns with the use of the following formula:

SAR_=AR_/SD_

where: SAR_it - standardised abnormal returns SD_it – standard deviation of the abnormal returns The SD_it is calculated with the use of the following formula:

SD_=_i^2*(1+\frac*\frac)

where: S_i² – the residual variance for firm i, R_mt – the return on the stock market index on day t, R_m – the average return from the market portfolio in the estimation period, T – the numbers of days in the estimation period.

Cumulative abnormal return

Cumulative abnormal return, or CAR, is the sum of all abnormal returns. Cumulative Abnormal Returns are usually calculated over small windows, often only days. This is because evidence has shown that compounding daily abnormal returns can create bias in the results.

References

{{DEFAULTSORT:Abnormal Return Equity securities Stock market

Stock market

Calculation

Cumulative abnormal return

See also

References